Dividend of the Week

The global banks have had a good run of late as they have been helped to rebuild their balance sheets via quantitative easing (QE) and also, closer to home, more specific schemes such as Funding for Lending and Help to Buy from the UK government, where the government has effectively mitigated lending risk by underwriting cheaper borrowing in an effort to kick-start both the housing market and the wider economy.

Love them or loathe them, the world's banks remain a huge integral part of the global economy and therefore should be represented in any reasonably diversified investment portfolio.

To start, we use DividendMax to select all of the banks we follow globally, which presents us with 31 companies. Given the state of distress that many banks still find themselves in, our opening criterion is for an expected dividend increase in the coming year and this yields us 17 companies. Tightening this with a second layer to screen for an annualised yield of more than 3 per cent reduces the list down to 12 banks that can be listed:

Banco Santander (MCE: SAN), HSBC (HSBA), Credit Suisse (SWX: CSGN), Barclays (BARC), Close Brothers (CBG), Wells Fargo (NYSE: WFC), Bank of Georgia (BGEO), JPMorgan Chase (NYQ: JPM), Standard Chartered (STAN), UBS (SWX: UBSN), Credit Agricole (PAR: ACA) and BNP Paribas (PAR: BNP). Two current investor favourites, Lloyds (LLOY) and RBS (RBS), do not appear as they have not paid a dividend for a long time. It would have been nice to have a closer look at Lloyds Banking, given its recent popularity and the likelihood that more of the government's stake will be sold off in the coming year, but its recent lack of dividends excludes it from this analysis.

I do not profess to be any sort of an expert on banking stocks, so we are going to rely on our tools to pick out the stronger companies and try to weigh that up against the increased risk of buying some of the very high yields that can be had from those banks that are perceived to be weaker.

We add in a further screen of a CADI (consecutive annual dividend increase) of greater than one to give us some indication that the banks in question are beginning a sustained recovery from the financial crisis. This eliminates the two French banks, Credit Agricole and BNP Paribas, and Credit Suisse.

Banco Santander has a fabulous yield, calculated at a forward annualised rate of 9.5 per cent by the DividendMax tool, and investors may well be tempted by it. If so, contact your broker and discuss the withholding tax situation which the Spanish government has levied since 1 January 2012 at the rate of 21 per cent. This can be reduced to 15 per cent if you fill in the appropriate paperwork. But with the Spanish economy, and in particular is real estate sector, still in a moribund state, it is very difficult to comfortably recommend any Spanish banks right now, even a pan-European business such as Santander. There is also a significant risk with any Spanish banking dividends at the moment that political pressure will lead to dividend payments being reduced after the Spanish government went on record over the summer to criticise the level of dividends being paid by its banks and recommended cash payouts be restricted to 25 per cent of profits. When the yield gets up as high as Santander's has, the market is telling you something, so we eliminate Santander at this point. I would also be worried about JPMorgan, which is currently in the process of settling with the US authorities on what will be the largest fine ever imposed upon a corporation. Add to that the potential reputational hit and that is just too much for shareholders to bear, which means we also eliminate JPMorgan.

To further reduce the shortlist, we tighten up the CADI criterion to three years of consecutive rises, which brings us to our list of five stocks.

This leaves three UK banks who emerged from the financial crisis relatively unscathed - Close Brothers, Standard Chartered and HSBC, as well as Barclays and JPMorgan - who all meet the CADI of three criterion. But we have already eliminated JPMorgan for the short-term reasons mentioned above.

At this point we can look at the fundamentals:

It is worth noting that the annualised yields shown in the table refer to forward annualised yields as calculated by the DividendMax tool. This involves looking forward at the next three forecast dividends and working out the potential annualised return.

Close Brothers was once top of the optimiser, when the share price was half what it is today, but it has rallied very strongly and now yields significantly less than the other three. The company has been building its dividend cover over the past couple of years to what is now a very respectable level of two times. From this level, we can expect that earnings increases will feed through to dividend increases proportionately.

HSBC's shares are trading in the middle of their 52-week trading range, which means they do not look expensive at this level. There is little doubt that through the financial crisis HSBC was one of the world's strongest banks despite a disastrous foray into US sub-prime, which it largely exited in 2009 by closing down the HSBC finance arm with the loss of 6,000 jobs. More recently, it also had to pay a record $1.92bn (£1.2bn) fine for money laundering of behalf of drug cartels in Mexico. HSBC's global reach, and strong exposure to Asia in particular, has helped it to ride out localised problems, but the fact that its shares went ex-dividend for the third quarter dividend at the close of play on 22 October also plays against it.

Barclays was much harder hit by the financial crisis, but managed to avoid a UK government bailout by using Middle Eastern investors, who in turn made a very tidy sum out of it. Additionally, it had to sell Barclays Global Investors, and with it the excellent iShares business, to BlackRock as part of its process of shoring up its balance sheet. In my view, that was a big loss for shareholders. But credit has to be given for not purchasing ABN AMRO in 2007, which was more by luck than judgement, or Barclays would be in the same position as RBS is in right now.

Standard Chartered was not hit by the financial crisis in anything like the same way as the other two larger banks and went about its business of growing in Asia Pacific and the Gulf as normally as possible given what was going on elsewhere. It did suffer during the financial crisis in Dubai that struck in November 2009, but was eventually able to declare that the impairments from it would "not be material". Most recently, the shares took a walloping when the bank was accused of money laundering in Iran. The speedy settlement of $340m fine looks perfectly manageable, but it should be noted that investigations by the US treasury are still ongoing.

Let's have a look at the dividends paid by each company over the past six to seven years:

Close Brothers

HSBC

2013 third-quarter dividend declared at 6.275p; goes ex dividend on 23 October

Standard Chartered

2013 half-year dividend of 18.5p paid

Barclays

2013 first- and second-quarter dividends of 1p paid

So, what are brokers saying about the four survivors? The table below represents the number of brokers in each of the recommendations categories of buy, hold and sell.

Given that it is the only one of the four that has managed to maintain dividend increases over the past six years, albeit only marginal increases at the height of the financial crisis, Standard Chartered's shares look very good value at these levels. True, the Iran scandal cost the bank $340m in fines and probably quite a lot more in reputational damage, but the company has strong emerging markets exposure which should stand it in good stead in the long run. Recent wobbles in confidence in these markets have held back the shares of late, but as a quality play on the long-term structural growth of emerging markets, the bank is hard to beat. Standard Chartered is the only bank that DividendMax covers that has managed to increase its dividend throughout the whole of the financial crisis, and indeed it has done so since at least the year 2000, and for that reason it is our dividend of the week.